Question

ou currently own $100,000 worth of Wal-Mart stock. Suppose that Wal-Mart has an expected return of 14% and a volatility of 23%. The market portfolio has an expected return of 12% and a volatility of 16%. The risk-free rate is 5%. Required: Assuming the CAPM assumptions hold, what alternative investment has the highest possi

Answer 1

Answer:

return = 20.81%

Explanation:

Capital Asset Pricing Model:

The capital asset pricing model (CAPM) is used to calculate the required rate of return for any risky asset.

Formula:

return = risk free + ( beta * ( market return-risk free ) )

where

beta is the standard deviation of the capital market line

Formula for standard deviation:

The standard deviation of the capital market line = x * standard deviation of market return    

As Wal-Mart has an expected return of 14% and a volatility of 23%. The market portfolio has an expected return of 12% and a volatility of 16%.

Therefore by putting the values in the above formula, we get

0.23 = x * 0.16

x = 1.4375  

As the risk-free rate is 5% and the market portfolio has an expected return of 12%

x = 5% + ( 1.4375 * ( 12% - 5% ) )

x = 20.81%

so return = 20.81%